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Currency Crosses

What is a Currency Cross Pair?

Back in the ancient days, if someone wanted to change currencies, they would first have to convert their currencies into U.S. dollars, and only then could they convert their dollars into the currency they desired.

For example, if a person wanted to change their U.K. sterling into Japanese yen, they would first have to convert their sterling into U.S. dollars, and then convert these dollars into yen.

With the invention of currency crosses, individuals can now bypass the process of converting their currencies into US dollars and simply convert it directly into their desired currency. Some examples of crosses include: GBP/JPY, EUR/JPY, EUR/CHF, and EUR/GBP.

Calculating Currency Cross Rates

Warning: This part is a little boring…unless you like numbers. It’s not difficult but it can be kind of dry. The good news is that this section really isn’t necessary anymore since most broker platforms already calculate cross rates for you.

However, if you are the type that likes to know how everything works, then this section is for you! And besides, it’s always good to know how things work right? In this section, we will show you how to calculate the bid (buying price) and ask (selling price) of a currency cross.

Let’s say we want to find the bid/ask price for GBP/JPY. The first thing we would do is look at the bid/ask price for both GBP/USD and USD/JPY.

Why these 2 pairs?

Because both of them have the U.S. dollar as their common denominator.

These 2 pairs are called the “legs” of GBP/JPY because they are the U.S. dollar pairs associated with it.

Now let’s say we find the following bid/ask prices:

GBP/USD: 1.5630 (bid) / 1.5635 (ask)

USD/JPY: 89.38 (bid) / 89.43 (ask)

To calculate the bid price for GBP/JPY, you simply multiply the bid prices for GBP/USD and USD/JPY.

If you got 139.70, good job! Your calculator is working properly, yipee!

To get the ask price for GBP/JPY, just multiply the ask prices for GBP/USD and USD/JPY and we get 139.82. Easy as pie!

Why Trade Currency Crosses?

Over 90% of the transactions in the forex market involve the U.S. dollar. This is because the U.S. dollar is the reserve currency in the world. You may be asking yourself, “Why the U.S. dollar and not the sterling, or euro?”

Most agricultural and industrial commodities such as oil are priced in U.S. dollars. If a country needs to purchase oil or other agricultural goods, it would first have to change its currency into U.S. dollars before being able to buy the goods. This is why many countries keep a reserve of U.S. dollars on hand. They can make purchases much faster with Greenbacks already in their pocket.

Countries such as China, Japan, and Australia are examples of heavy importers of oil, and as a result, they keep huge reserves of U.S. dollars in their central banks. In fact, China has almost a trillion U.S. dollars in its reserve stockpile!

So what does this all have to do with trading currency crosses? Well since most of the world is glued to the U.S. dollar, a majority of trading speculation will be based on one question:

“Is the U.S. dollar weak or strong today?”

This one question will affect many of the most liquid currency pairs:

The majors: GBP/USD, EUR/USD, USD/CHF, USD/JPY

The commodity pairs: AUD/USD, USD/CAD, NZD/USD

Notice that all of these pairs are tied to the U.S. dollar. This doesn’t give a trader many options when most of their trading decisions are based on this one speculation.

You can see that by trading any of the 7 most popular currencies, you are basically taking either an anti-U.S. dollar or pro-U.S. dollar stance. This one speculation affects these pairs in almost the same way across the board.

Conversely in the stock market, traders have multiple companies to choose from and are not bound to one major speculation idea.

With stocks, you can see that even though the overall market was positive, there are still plenty of other trading opportunities. There isn’t just one kind of speculation that affects the entire basket of stocks.

Currency Crosses Provide More Trading Opportunities

Instead of just looking at the seven “major” dollar-based pairs, currency crosses provide more currency pairs for you to find profitable opportunities!

By trading currency crosses, you give yourself more options for trading opportunities because these currencies are not bound to the U.S. dollar, thus possibly having different price movement behaviors. So while the majority of the markets will only trade on anti-U.S. dollar or pro-U.S. dollar sentiments, you can find new opportunities in currency crosses.

For example, all the dollar-based pairs might be trading sideways or in some uglier fashion where it would be smart to just sit on the sidelines and wait for better trade setups, but if you knew to switch your charts to look at currency crosses, you might just find trading opportunities galore!

Be different! The majority of traders just trade the majors. Now you can be part of the minority that trade currency crosses.

Currency Crosses Are Trend-y

Since a majority of the forex market will deal with the U.S. dollar, you can imagine that many of the news reports will cause U.S. dollar-based currency pairs to spike. The US has the largest economy in the world, and as a result, speculators react strongly to U.S. news reports, even if it doesn’t cause a huge fundamental shift in the long run.

What this means for your charts is that you will see several “spikes” even if there is a trend emerging. This can make it harder to spot trend or range indications.

The day to day economic activities of the U.S. can keep U.S. dollar based currencies such as EUR/USD (above) from making smooth trends.

Conversely, we can see that during the same date range, cross currency EUR/JPY made a much, much smoother ride to the top. This was probably due to less spikes that came from U.S. data. So as you can see, both charts showed the euro rise during the same time period, but the one without the U.S. dollar (EUR/JPY) made for a much easier trade.

If you are a trend following kinda dude, then currency crosses may be easier to trade than the major pairs. It will be easier for you to spot the trend and be more confident in your entry points because you know that these technical levels hold more than they do for the majors.

In the next section, we’ll discuss how playing with currency crosses can also allow you to take advantage of the interest rate differentials. Now that’s like a cherry on top of a sundae!

Trade Interest Rate Differentials

By selling currencies whose country has a lower interest rate against currencies whose country has a higher interest rate, you can profit from the interest rate differential (known as a carry trade) as well as price appreciation.

Currency crosses offer many pairs with high interest rate differentials that are prime for these types of trades.

For example, take a look at the nice uptrend on AUD/JPY. If you had a long position on this pair, you would’ve made a hefty profit.

On top of that, the interest rate differential between AUD and JPY was huge. From 2002 to 2007, the Reserve Bank of Australia had raised rates to 6.25% while the BOJ kept their rates at 0%.

That means you made profits off your long position AND the interest rate differential on that trade!

Be Careful Trading Obscure Currency Crosses

While the euro and yen crosses are the most liquid crosses, more currency crosses exist that don’t even include the U.S. dollar, euro, or the yen! We’ll call these the “Obscure Currency Crosses”!

That’s because most forex traders would rather hang out with the cool crowd than the obscure crosses!

Trading in these pairs can be more difficult and riskier than trading euro or yen currency crosses. Since very few forex traders trade them, transaction volume is much lower resulting in lower liquidity.

Due to the illiquid markets for these crosses, their prices can become quite volatile, so being stopped out on whipsaws can become a common occurrence.

Check out these screenshots of AUD/CHF and GBP/CHF:

You don’t want to get stopped out by those nasty spikes, do you? That’s why most forex traders usually put wider stops when trading these pairs.

But judging from the choppy movement of obscure crosses, it would really be tough to catch a good trade on these pairs.

See what we mean?

Also, since these currency cross pairs aren’t traded too much by forex traders, the spreads on these pairs can be pretty big.

If you want to trade these currency crosses, just be ready for some wild price swings and be willing to pay the price of the massive spread!

How to Trade Fundamentals With Currency Crosses

If strong economic data comes out of Australia, you might want to look at buying the AUD. Your first reaction might be to buy AUD/USD.

But what if at the same time, recent data also show the United States experiencing strong economic growth? Price action of AUD/USD may be flat.

One option that you have is to match the AUD against the currency of an economy that isn’t doing so well…. Hmmmm… what could you do?

Ah! Thank the forex gods for currency crosses!

Let’s say you did some analysis, checked the BabyPips.com economic calendar (shameless plug!) or Pip Diddy’s daily economic roundup (another shameless plug!) and you notice that the Japanese economy isn’t doing so good right now.

What do you do?

Of course, like any self-respecting bully, you jump all over this opportunity and go long AUD/JPY!

There’s nothing wrong with being a bully, at least not here at the School of Pipsology.

It’s your job as a forex trader to take advantage of certain opportunities so that you can put some silver dollars into your piggy bank.

Because of currency crosses, you now have the opportunity to match the currency of the best performing economy against that of the weakest economy without having to deal with the U.S. dollar.

Trading the Euro and Yen Crosses

After the U.S. dollar, the euro and yen are the most traded currencies. And like the U.S. dollar, the euro and yen are also held as reserve currencies by different countries. So this makes the euro and yen crosses the most liquid outside of the U.S. dollar-based “majors.”

Trading the Euro Crosses

The most popular EUR crosses are EUR/JPY, EUR/GBP, and EUR/CHF.

News that affects the euro or Swiss franc will be felt more in EUR crosses than EUR/USD or USD/CHF.

Oddly enough, U.S. news plays a part in the movement of the EUR crosses. U.S. news makes strong moves in GBP/USD and USD/CHF. This not only affects the price of the GBP and CHF against the USD, but it could also affect the GBP and CHF against the EUR.

A big move higher in the USD will tend to see a higher EUR/CHF and EUR/GBP and the same goes for the opposite direction.

Confused? Ok ok…let’s break this down.

Let’s say that the U.S. shows positive economic data causing the USD to rise. This means that GBP/USD would fall, driving the price of the GBP down. At the same time USD/CHF would rise, also driving the price of the CHF down.

The drop in GBP price would then cause EUR/GBP to rise (since traders are selling off their GBP).

The drop in CHF price would also cause EUR/CHF to rise (since traders are selling off their CHF).

Conversely, this would also work in the opposite direction if the U.S. showed negative economic data.

Trading the Yen Crosses

The JPY is one of the more popular cross currencies and it is basically traded against all of the other major currencies.

GBP/JPY, AUD/JPY, and NZD/JPY are attractive carry trade currencies because they offer the highest interest rate differentials against the JPY.

When trading JPY currency cross pairs, you should always keep an eye out on the USD/JPY. When key levels are broken or resisted on this pair, it tends to spill over into the JPY cross pairs.

For example, if USD/JPY breaks out above a key resistance area, it means that traders are selling off their JPY. This could prompt the selling of the JPY against other currencies. Therefore you could expect to see EUR/JPY, GBP/JPY, and other JPY crosses to rise as well.

The CAD/JPY

Over recent years, this currency cross has become very popular, becoming highly correlated with the price of oil.

Canada is second largest owner of oil reserves and has benefited with the rise of oil prices.

On the other hand, Japan is heavily reliant on the importing of oil. In fact, over 99% of Japan’s crude oil is imported as it has almost no native oil reserves.

These two factors have caused an 87% positive correlation between the price of oil and CAD/JPY.

How to Use Currency Crosses to Trade the Majors

Even if you don’t ever want to trade the currency crosses and simply stick to trading the majors, you can use crosses to help you make better forex trading decisions.

Here’s an example…

Currency crosses can provide clues about the relative strength of each major currency pair.

Let’s say you see a buy signal for EUR/USD and GBP/USD but you can only take one trade.

Which one do you take?

Simply looking at your crystal ball and guessing isn’t likely to result in the right answer.

To find the right answer, you would look at EUR/GBP cross.

If EUR/GBP is trending downward, this indicates that the pound is relatively stronger than the euro at the moment.

So the right answer would be to buy GBP/USD instead of EUR/USD due to the pound’s relative strength against the euro.

Since the euro is weaker, relative to the pound, if it proves to strengthen against the U.S. dollar, it is likely to strengthen LESS than the pound.

If the U.S. dollar weakens across the board, GBP/USD you would make more pips since it would rally higher than EUR/USD.

So GBP/USD is the better trade.

You can do this relative strength analysis on any of the major currency pairs.

Know Which Currency Cross to Use

Let’s say you’re bearish on the U.S. dollar. How will you trade?

Can’t decide whether to buy EUR/USD or sell USD/CHF? Look at EUR/CHF.

Can’t decide whether to buy USD/CHF or USD/JPY? Look at CHF/JPY.

Can’t decide whether to buy EUR/USD or sell USD/JPY? Look at EUR/JPY.

Can’t decide whether to buy GBP/USD or sell USD/CHF? Look at GBP/CHF.

Can’t decide whether to buy GBP/USD or sell USD/JPY? Look at GBP/JPY.

So always remember, looking at currency cross pairs could give you an idea of the relative strength of a particular currency.

How Cross Currency Pairs Affect Dollar Pairs

Let’s pretend the Fed announces they will raise interest rates. The market quickly starts buying the U.S. dollar across all major currencies….EUR/USD and GBP/USD fall while USD/CHF and USD/JPY rise.

You were short EUR/USD and were pleased to see price move in your favor making you some pips, but right before you were about to break out the cigar, you notice your friend who was long USD/JPY made a lot more pips than you.

You’re like “What’s up with that yo?”

You compare the charts of EUR/USD and USD/JPY and see that USD/JPY made the bigger move. It broke through a major technical resistance level and shot up 200 pips while EUR/USD barely shot down 100 pips and failed to break a major support level.

You’re thinking to yourself, “If the U.S. dollar was being bought across the board, then how come my EUR/USD trade looks so weak compared to my friend’s USD/JPY trade?”

This is due to the currency crosses! In this particular example, EUR/JPY.

When USD/JPY broke through its major resistance level, the combination of stop losses being hit and breakout traders jumping on the bandwagon pushed it even higher.

Since buying more USD/JPY weakens the yen, this would cause EUR/JPY (and possibly other yen-based pairs) to break through its major resistance level, once again hitting stops and attracting breakout traders, pushing EUR/JPY even higher.

This causes the euro to strengthen and slows down the descent of your EUR/USD trade. The EUR/JPY cross buying acts a “parachute” and this is why EUR/USD didn’t move as much or as fast as the USD/JPY.

So even if you only trade the major currencies, cross currency pairs still have an effect on your trades!